The summer of 1972 had the break-in at the Watergate office complex in Washington DC on June 17. While that event is now the subject of history books, an event that took place just over a month later just recently was the featured issue in tax litigation. In the case of Estate of Redstone v. Commissioner, 145 TC No. 11 the issue became whether or not a gift had taken place back in 1972, a gift the IRS now sought to collect gift tax on. Since no gift tax return had been filed, the statute remained open for the IRS to assess and attempt to collect the tax it claimed was due.
The decedent (Edward) had worked in a family business with his father and brother. The decedent had issued shares equal to a 33 1/3% interest in the business, even though he had only contributed assets that, in value, made up only 25.63% of the contributions of the three owners (himself, his father and brother).
Edward eventually was forced out of the business after having a falling out with the other members of the family. When he demanded his shares in the company, his father refused to give them to him. Based on the unequal contributions, his father insisted that a portion of Edward’s shares had been placed in an “oral trust” for Edward’s children.
Litigation ensued with regard to the stock that become quite acrimonious and garned unwanted publicity. As the Court noted:
This litigation became quite adversarial, and its public nature was extremely distressing to the Redstone family, especially to Mickey's wife (and Edward's mother) Belle. She implored Edward to reach some accommodation with his father. In the course of negotiations, it became apparent to Mr. DeGiacomo that Edward had to separate completely from NAI and that Mickey would not be placated unless Edward acknowledged the supposed "oral trust" and placed some of the disputed shares in trust for his children, Michael and Ruth Ann.
A settlement was ultimately reached along these lines. Notwithstanding that 100 shares of NAI voting common stock were registered in Edward's name, the parties agreed that Edward was the owner "free and clear of all trusts, restrictions and encumbrances" of only 66 2/3 shares of such stock. They further agreed that the remaining 33 1/3 shares of NAI stock registered in Edward's name were then held, and had always been held by Edward, "for the benefit of his children * * * in trust and not as beneficial owner." This settlement was a compromise of the parties' respective positions. It reflected, on the one hand, Mickey's desire to ensure the financial security of Edward's children and, on the other hand, Edward's desire to conclude the litigation by securing payment for at least a portion of his shares.
The parties agreed that NAI would purchase from Edward the 66 2/3 shares of stock that he was deemed to own. They further agreed that "Ed's 2/3 stock interest was to be valued at Five Million Dollars for purposes of a settlement agreement" dated June 30, 1972 (Settlement Agreement). Edward executed an assignment transferring to NAI, in exchange for $5 million, 66 2/3 shares of NAI voting common stock.
The Settlement Agreement further required Edward to execute irrevocable declarations of trust, likewise dated June 30, 1972, for the benefit of his children. These trusts were styled the Ruth Ann Redstone Trust (Ruth Ann Trust) and the Michael David Redstone Trust (Michael Trust). Sumner was named the sole trustee of each trust. Edward executed two assignments, each transferring 16 2/3 shares of NAI stock to Sumner as trustee of the respective Trusts.
Finally, the Settlement Agreement required the parties to execute various releases. All parties executed mutual releases respecting claims concerning Edward's ownership interests in NAI and Northeast. Edward resigned from all positions he had held in the Redstone family businesses and resigned as trustee (or relinquished the right to serve as successor trustee) of all Redstone family trusts. The Settlement Agreement also resolved certain disputes in the Northeast Action that are not relevant here.
On July 19, 1972, the parties filed with the Massachusetts Superior Court a Stipulation in the NAI Action setting forth the terms of this settlement. That same day, the Massachusetts Superior Court issued a Final Decree incorporating the terms of the Settlement Agreement.
At the time of this settlement, despite Edward’s insistence that he truly had a right to all the stock and that no such oral agreement existed, no gift tax return was filed by Edward for the transfer of 1/3 of his shares to his children via the trust. The IRS sought to have that transaction treated as a gift, imposing the tax due, as well as interest and penalties based on the original due date of the gift tax return for a 1972 gift.
The Tax Court did not agree. The Court found that this transfer was for “full and adequate consideration” and was not transferred to his children for less than such full and adequate consideration. The Court summarized the test as follows:
A transfer of property will be regarded as occurring "in the ordinary course of business" and thus will be considered to have been made "for an adequate and full consideration in money or money's worth" only if it satisfies the three elements specified in section 25.2512-8, Gift Tax Regs. To meet this standard, the transfer must have been bona fide, transacted at arm's length, and free of donative intent. In applying this regulation to settlements of family disputes, we have identified certain subsidiary factors that may also be relevant. We have considered, for example: whether a genuine controversy existed between the parties; whether the parties were represented by and acted upon the advice of counsel; whether the parties engaged in adversarial negotiations; whether the value of the property involved was substantial; whether the settlement was motivated by the parties' desire to avoid the uncertainty and expense of litigation; and whether the settlement was finalized under judicial supervision and incorporated in a judicial decree. See, e.g., Estate of Natkanski, 64 T.C.M. (CCH) at 59; Estate of Noland, 47 T.C.M. (CCH) at 1644-1645.
With regard to the question of whether the transfer was bona fide rather than simply a sham designed to disguise a gift, the Court noted:
Edward was not working in concert with Mickey or Sumner in any sense of the word. To the contrary, Edward was genuinely estranged from his father and his brother during 1971-1972, and this estrangement grew worse as time went on. On both the business and family fronts, Edward had legitimate grievances against Mickey and Sumner, and they had (or thought they had) legitimate grievances against him.
Even though, as the Court noted, “[t]he Massachusetts courts, 37 years later, ultimately found insufficient evidence that an oral trust was ever created,” the theory was plausible enough in 1972 to support the idea that Edward transferred the stock in trust due to the risk that the Court might have found that a trust existed to hold a much larger portion of the stock.
The antagonism between the parties also made it clear that selling price was part of an arms length negotiation.
All the elements of arm's-length bargaining existed here. There was a genuine controversy among Edward, Mickey, and Sumner; they were represented by and acted upon the advice of counsel; they engaged in adversarial negotiations for a protracted period; the compromise they reached was motivated by their desire to avoid the uncertainty and embarrassment of public litigation; and their settlement was incorporated in a judicial decree that terminated the lawsuits. Because Edward acted "as one would act in the settlement of differences with a stranger," his transfer of shares in trust for his children was an arm's-length transaction. See Beveridge, 10 T.C. at 918; Estate of Natkanski, 64 T.C.M. (CCH) at 59; Estate of Noland, 47 T.C.M. (CCH) at 1644-1645; Lampert, 15 T.C.M. (CCH) at 1189-1190.
On the issue of donative intent, the Court found that even though he may have had positive feelings towards his children, this particular transaction was not done with pure donative intent. Instead the Court noted:
We find that Edward acquiesced in the notion of an "oral trust" because he had no other alternative; this was a "deal breaker" for Mickey. There is no evidence that Edward, in making this transfer, was motivated by love and affection or other feelings that normally prompt the making of a gift. Because Edward's transfer of stock to his children represented the settlement of a bona fide dispute, was made at arm's length, and was "free from any donative intent," it meets the three criteria for a transaction "in the ordinary course of business" specified in section 25.2512-8, Gift Tax Regs.
The IRS noted that despite the above there was still a problem—the children had clearly provided no consideration for the stock. Thus, the IRS argued, it was a transfer to them for less than full and adequate consideration.
But the Court said the IRS was looking at the wrong side of the transaction. As the Court held:
Respondent's argument focuses on whether the transferees provided consideration. But that is not the question the regulation asks. It asks whether the transferor received consideration, that is, whether he made the transfer "for a full and adequate consideration" in money or money's worth. Sec. 25.2511-1(g)(1), Gift Tax Regs. (emphasis added). We have determined that Edward received "a full and adequate consideration" for his transfer -- namely, the recognition by Mickey and Sumner that Edward was the outright owner of 66 2/3 NAI shares and NAI's agreement to pay Edward $5 million in exchange for those shares. Section 2512(b) and its implementing regulations require that the donor receive "an adequate and full consideration"; they make no reference to the source of that consideration.
Thus the Tax Court held that, in fact, there was no gift in 1972 and, therefore, no gift tax was due.